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Micro Review
Game Theory and Taxation
Dominant Strategy
• One strategy is better for a given player, regardless of what his/her opponent chooses to do
•
Uptown: DominantStrategy = LowRareair: Dominant Strategy = Low
Game TheoryGame Theory Model to Analyze Behavior
RareAir’s Price Strategy
Upt
own’
s Pr
ice
Stra
tegy
A B
C D
$12
$12
$15
$6
$8
$8
$6
$15
High
High
Low
Low•2 Competitors•2 Price Strategies•Each Strategy Has
a Payoff Matrix
O 23.2
Nash EquilibriumNash Equilibrium
NASH EQUILIBRIUM : when each player is pursuing their best possible strategy in the full knowledge of the other players’ strategies. A Nash equilibrium is reached when nobody has any incentive to change their strategy.
John F. Nash, 1928 - Russell Crow portrays John Nash in A Beautiful Mind
An Example of a Nash Equilibrium
a b
b 2,1
0,1
1,0
1,2
Row
Column
a
(b,a) is a Nash equilibrium.To prove this: Given that column is playing a, row’s best response is b. Given that row is playing b, column’s best response is a.
Tax IncidenceEfficiency Loss of a Tax
0
2
4
6
8
10
12
14
5 10 15 20 25 Q
P
Pri
ce (
Per
Bo
ttle
)
Quantity(Millions of Bottles Per Month)
S
D
S’
Tax $2
Tax Paid byConsumers
Tax Paid byProducers
EfficiencyLoss (or
DeadweightLoss)
Tax Incidence
0
P
P
0
Tax Incidence andElastic Demand- burden on the
supplier
Tax Incidence andInelastic Demand- burden on
the consumer
Demand Elasticity and the Incidenceof an Excise Tax
De
Dt
Tax TaxSt
S
St
S
Q2
P1
Pe
Pa
P1
Pi
Pb
Q1 Q2Q1
aa
b
b
cc
